Sunday, December 21, 2008

More criticism of the Paulson bailout plan

Pietro Veronesi and Luigi Zingales accuses that the revised Paulson bailout plan ($125bn equity infusion in the nine largest U.S. commercial banks, in return for preferred equity with a nominal value equal to the amount invested, and a three year Government, through FDIC, guarantee on all new bank debt issues), with its emphasis on equity injections, creates no value to the banking system, amounts to a massive redistribution from taxpayers to bondholders, and enriches Wall Street cronies!

They write that the plan "increased the value of banks’ financial claims by $109 billion at a taxpayers’ cost of $112 -135 bns, creating no value in the banking sector. The biggest beneficiaries of this massive redistribution were the debtholders of financial institutions, especially those of the three former investment banks and of Citigroup. The equity holders just broke even."

Luigi Zingales suggests that the channel for equity injections should have been different. He feels that a better option would have been for the FDIC to take equity stakes in the borrowing banks, by swapping their debts as equity.

Alan Blinder is equally scathing in his indictment, arguing that the preferred stocks, with no control rights, were puchased often at above-market prices and with no public-purpose strings attached. He writes, "The 5% dividend rate that taxpayers will generally receive is half what Warren Buffett got from Goldman Sachs. Banks receiving capital injections through the front door are generally allowed to pay dividends out the back door. And there are no public-purpose quid pro quos, such as a minimal lending requirement. So banks can just sit on the capital, which is what most of them have done, or use it to make acquisitions, as a few have."

He feels that the crisis cannot be settled without addressing the issue of mounting foreclosures. This would require re-financing home mortgages (so that foreclosures that destroy real estate values and force fire sales of homes are contained) and buying "illiquid and now worthless" troubled assets (so that these assets start getting traded and their valuations get established).

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